Investment club or co-investment club?

Guy Davies, managing partner of private equity house WestBridge Capital, explains why investment clubs can be full of pitfalls.

Investment clubs have historically been attractive as a source of investment opportunities for entrepreneurs who’ve made their first few million. However, there are many pitfalls for uninitiated investors.

These clubs bring together companies seeking investment with investors/business angels who have surplus funds and an appetite to invest. Typically, these companies will be in the earlier stages of development. Some may still be waiting to breakeven. Most will be also looking for experience and advice to support their growth.

Business angels are typically highly-driven ex-company owners, disappointed that retirement hasn’t turned out to be all it’s cracked up to be. Most want to stay involved in business and have allocated a small proportion of their wealth to higher-risk investments.

The pitfalls

The private investment sector is littered with casualties -angels who’ve let their enthusiasm overtake their judgment. Sadly, many have lost significant amounts of money. Here are the four of the key reasons (DUDS) why they’ve had their fingers burnt

1) Due diligence

Investors have to undertake their own due diligence, which frequently fails to reveal issues.

2) Unrealistic forecasts

Forecasts prepared by early stage companies can be unrealistic but very intoxicating for the inexperienced investor. They project the enthusiasm, ambition and optimism of the company’s MD rather than a conservative prediction of what’s achievable.

3) Doubtful management

Management teams need to be appropriate both in terms of experience and cultural fit. Managers from large corporates may find themselves out of their depth in small, evolving companies.

4) Stamina

Creating and growing a successful business should be viewed as a marathon, not a sprint. Investors may need to have the financial resources to make further rounds of investment if necessary.

Co-investment – a better alternative

By contrast, many investors are increasingly seeking to co-invest, hand-in-in hand, with established private equity investors. These illusive collaborations can be groups, clubs or ‘friends and family’ arrangements.

Put simply, the professional investors invite individuals to invest alongside them, on the same terms, as their managed Funds.

There are benefits for all involved.

The private equity house expands its pool of funds, experience and contacts.

The investee company benefits from having a wider skillset to tap into and the wisdom of successful and seasoned entrepreneurs to draw on.

The inexperienced investor benefits from a flow of attractive investment opportunities that have already been rigorously qualified.

How it works

Most co-investment clubs are invitation-only groups of successful entrepreneurs. Members are invited to invest modest amounts – typically £50k – in hand-picked businesses being funded by the private equity house. WestBridge Capital, for instance, has a co-investment club called WestBridge 100.

The investment opportunities presented are lower risk. They are professionally structured transactions in profitable established businesses. Growth, acquisition and MBO capital is generally provided to established and profitable UK businesses, along with a helping hand.

Clearly, a mutually beneficial relationship for all concerned, with no DUDS.